Consider the following list of projects:
Assuming that your capital is constrained, which investment tool should you use to
determine the correct investment decisions?
A) Profitability Index
B) Incremental IRR
C) NPV
D) IRR
Answer:
Use the following information to answer the question(s) below.
Rearden Metal is considering the purchase of a new blast furnace costing a total of $5
million dollars. This furnace will qualify for accelerated depreciation: 20% can be
expense immediately, followed by 32%, 19.2%, 11.52%, 11.52% and 5.76% over the
next five years. However, because of Rearden’s substantial tax loss carry forwards,
Rearden estimates its marginal tax rate to be only 10% over the next five years. Since
Rearden will get very little tax benefit from the depreciation expense, they consider
leasing the furnace instead. Suppose that Rearden and the lessor face the same 8%
borrowing rate, but the lessor has a 40% marginal tax rate. Assume that the furnace is
worthless after five years, the lease term is five years, and a lease would qualify as a
true tax lease.
Assuming that Rearden’s annual lease payments are $1.1 million, then Rearden Metal
should
A) lease the furnace since the amount saved in year zero from leasing is greater than the
amount of the lease equivalent loan.
B) buy the furnace since the amount saved in year zero from leasing is greater than the
amount of the lease equivalent loan.
C) lease the furnace since the amount saved in year zero from leasing is less than the
amount of the lease equivalent loan.
D) buy the furnace since the amount saved in year zero from leasing is less than the
amount of the lease equivalent loan.
E) Rearden will be indifferent between buying and leasing since the amount saved in
year zero from leasing equals the amount of the lease equivalent loan.
Answer:
Which of the following statements is false?
A) In exchange for bearing systematic risk, investors want to be compensated by
earning a higher return.
B) A key step to measuring systematic risk is finding a portfolio that contains only
unsystematic risk.
C) When evaluating the risk of an investment, an investor will care about its systematic
risk, which cannot be eliminated through diversification.
D) To measure the systematic risk of a stock, we must determine how much of the
variability of its return is due to systematic, market-wide risks versus diversifiable, firm
specific risks.
Answer:
Use the information for the question(s) below.
The Aardvark Corporation is considering launching a new product and is trying to
determine an appropriate discount rate for evaluating this new product. Aardvark has
identified the following information for three single division firms that offer products
similar to the one Aardvark is interested in launching:
The unlevered cost of capital for Anteater Enterprises is closest to:
A) 10.1%
B) 9.5%
C) 9.9%
D) 10.3%
Answer:
Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or
$117,000 in a strong economy, with each outcome being equally likely. The initial
investment required for the project is $80,000, and the project’s cost of capital is 15%.
The risk-free interest rate is 5%.
Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the
risk free rate, then the value of the firm’s levered equity from the project is closest to:
A) $0
B) $10,000
C) $6,000
D) $8,600
Answer:
Wyatt Oil purchases goods from its suppliers on terms 3/20 net 40. The effective annual
cost to Wyatt if they do not take the discount and pay on day 40 is closest to:
A) 18%
B) 45%
C) 75%
D) 82%
Answer:
Use the following information to answer the question(s) below.
All amounts are in millions.
If the risk-free rate is 3% and the market risk premium is 5%, then the CAPM’s
predicted expected return for Wyatt Oil is closest to:
A) 8.5%
B) 9.0%
C) 9.5%
D) 10.0%
Answer:
Use the table for the question(s) below.
If the risk-free interest rate is 10%, then the NPV for Eenie is closest to:
A) -3.64
B) 2.73
C) 3.18
D) 3.64
Answer:
If the risk-free rate of interest (rf) is 3.5%, then you should be indifferent between
receiving $1000 in one-year or
A) $965.00 today.
B) $966.18 today.
C) $1000.00 today.
D) $1035 today.
Answer:
Use the information for the question(s) below.
You founded your own firm three years ago. You initially contributed $200,000 of your
own money and in return you received 2 million shares of stock. Since then, you have
sold an additional 1 million shares of stock to angel investors. You are now considering
raising capital from a venture capital firm. This venture capital firm would invest $5
million and would receive 2 million newly issued shares in return.
Assuming that this is the venture capitalist’s first investment in your firm, what
percentage of the firm will you own?
A) 50%
B) 40%
C) 33%
D) 25%
Answer:
Use the following information to answer the question(s) below.
A default-free security has an annual coupon rate of 3.25% and sells for par. This bond
will mature in:
A) 1 year
B) 2 years
C) 3 years
D) 4 years
Answer:
Luther Industries has a dividend yield of 4.5% and and a cost of equity capital of 12%.
Luther Industries dividends are expected to grow at a constant rate indefinitely. The
grow rate of Luther’s dividends are closest to:
A) 7.5%
B) 5.5%
C) 16.5%
D) 12%
Answer:
The distinguishing feature of a corporation is that
A) their is no legal difference between the corporation and its owners.
B) it is a legally defined, artificial being, separate from its owners.
C) it spreads liability for its corporate obligations to all shareholders.
D) provides limited liability only to small shareholders.
Answer:
Use the following information to answer the question(s) below.
Consider the following four alternatives:
1. $132 received in two years.
2. $160 received in five years.
3. $200 received in eight years.
4. $220 received in ten years.
The ranking of the four alternatives from most valuable to least valuable if the interest
rate is 6% per year would be:
A) 1, 2, 3, 4
B) 1, 3, 2, 4
C) 4, 3, 1, 2
D) 3, 4, 2, 1
Answer:
Use the table for the question(s) below.
Luther Industries currently has the following balance sheet (in Thousands of dollars):
Luther is about to add a new fleet of delivery trucks. The price of the fleet is $1.5
million.
If Luther acquires the new fleet of delivery trucks using a capital lease, Luther’s Debt to
Equity ratio will be closest to:
A) 0.66
B) 1.5
C) 0.80
D) 2.0
Answer:
A credit default swap is essentially a
A) put option on the firm’s assets.
B) call option on the firm’s assets.
C) put option on the firm’s debt.
D) call option on the firm’s debt.
Answer:
Which of the following statements is false?
A) Because interest rates may be quoted for different time intervals, it is often
necessary to adjust the interest rate to a time period that matches that of our cash flows.
B) The effective annual rate indicates the amount of interest that will be earned at the
end of one year.
C) The annual percentage rate indicates the amount of simple interest earned in one
year.
D) The annual percentage rate indicates the amount of interest including the effect of
compounding.
Answer:
Which of the following statements is false?
A) An alternative to using the Black-Scholes formula is to compute the value of growth
options using risk neutral probabilities.
B) Future growth options are not only important to firm value, but can also be
important in the value of an individual project.
C) While the Black-Scholes formula values American options, most growth options
cannot be exercised at any time.
D) Out-of-the-money calls are riskier than in-the-money calls, and because most growth
options are likely to be out-of-the-money, the growth component of firm value is likely
to be riskier than the ongoing assets of the firm.
Answer:
Use the following information to answer the question(s) below.
Consider the price paths of the following stocks over a six-month period:
None of these stocks pay dividends.
Assume that you are an investor with the disposition effect and you bought each of
these stocks in January. Suppose that it is currently the end of June, which stocks are
you most inclined to sell?
1. Taggart Transcontinental
2. Rearden Metal
3. Wyatt Oil
4. Nielson Motors
A) 1 only
B) 1 & 3 only
C) 2 only
D) 1, 2 & 3 only
Answer:
Which of the following statements is false?
A) The unlevered beta measures the market risk of the firm’s business activities,
ignoring any additional risk due to leverage.
B) If a firm holds $1 in cash and has $1 of risk-free debt, then the interest earned on the
cash will equal the interest paid on the debt. The cash flows from each source cancel
each other, just as if the firm held no cash and no debt.
C) The unlevered betameasures the market risk of the firm without leverage, which is
equivalent to the beta of the firm’s assets.
D) When a firm changes its capital structure without changing its investments, its
levered beta will remain unaltered, however, its asset beta will change to reflect the
effect of the capital structure change on its risk.
Answer:
A(n) ________ cash flows come from the cash flows of underlying financial securities.
A) general obligation security’s
B) revenue bond’s
C) asset-backed security’s
D) double-barreled bond’s
Answer:
Wyatt Oil has 8 million shares outstanding and is about to issue 10 million new shares
in an IPO. The IPO price has been set at $15 per share, and the underwriting spread is
6%. The IPO is a big success with investors, and the share price rises to $35 the first
day of trading.
The market value of Wyatt Oil after the IPO is closest to:
A) $329 million
B) $350 million
C) $592 million
D) $609 million
E) $630 million
Answer:
Which of the following statements is false?
A) In the case of a Treasury note or Treasury bond offering, the stop-out yield
determines the coupon of the bond and then all bidders pay the discounted value for the
bond or note.
B) All competitive bidders submit sealed bids in terms of yields and the amount of
bonds they are willing to purchase.
C) In the past, the Treasury has issued bonds with maturities of 30 years (often called
long bonds) and 20 years.
D) Noncompetitive bidders (usually individuals) just submit the amount of bonds they
wish to purchase and are guaranteed to have their orders filled at the auction.
Answer:
Suppose that Nielson Motors stock is trading for $50 per share and that Nielson pays no
dividends. What is the minimum possible price for an American put option on Nielson
Motors with a strike price of $70?
A) $0
B) $20
C) $50
D) infinite
Answer:
Use the information for the question(s) below.
You expect CCM Corporation to generate the following free cash flows over the next
five years:
Following year five, you estimate that CCM’s free cash flows will grow at 5% per year
and that CCM’s weighted average cost of capital is 13%.
The enterprise value of CCM corporation is closest to:
A) $396 million
B) $290 million
C) $382 million
D) $350 million
Answer:
Shepard Industries expects free cash flow of $10 million each year. Shepard’s corporate
tax rate is 35%, and its unlevered cost of equity is 10%. The firm also has outstanding
debt of $40 million and it expects to maintain amount of debt permanently.
The value of Shepard Industries without leverage is closest to:
A) $114 million
B) $50 million
C) $100 million
D) $64 million
Answer:
Which of the following statements is false?
A) In the real world, specific projects should differ only slightly from the average
investment made by the firm.
B) We can estimate rUfor a new project by looking at single-division firms that have
similar business risks.
C) The project’s equity cost of capital depends on its unlevered cost of capital, rU, and
the debt-equity ratio of the incremental financing that will be put in place to support the
project.
D) Projects may vary in the amount of leverage they will support”for example,
acquisitions of real estate or capital equipment are often highly levered, whereas
investments in intellectual property are not.
Answer:
Use the information for the question(s) below.
In a surprise announcement, NASA released details of a major contract with
Lockheed-Martin (LMT) that would increase LMT’s market value by $7.5 billion. It
was widely expected by the market that this contract would be awarded to LMT’s major
competitor Boeing (BA). Assume that Boeing has 800 million shares outstanding and
Lockheed Martin has 425 million shares outstanding. Prior to this announcement, the
market felt that the probability of Boeing winning the contract was 90% and that
Lockheed-Martin’s chance was only about 10%.
What do you anticipate will happen to Lockheed-Martin and Boeings’ stock prices are a
result of this surprise announcement?
Answer:
Use the information for the question(s) below.
Tom’s portfolio consists solely of an investment in Merck stock. Merck has an expected
return of 13% and a volatility of 25%. The market portfolio has an expected return of
12% and a volatility of 18%. The risk-free rate is 4%. Assume that the CAPM
assumptions hold in the market.
Assuming that Tom wants to maintain the current expected return on his portfolio, then
the minimum volatility that Tom could achieve by investing in the market portfolio and
risk-free investment is closest to:
A) 20%
B) 25%
C) 22%
D) 18%
Answer:
Use the tables for the question(s) below.
Pro Forma Income Statement for Ideko, 2005-2010
Pro Forma Balance Sheet for Ideko, 2005-2010
Assuming that Ideko has a EBITDA multiple of 9.4, then the continuation EV/Sales
ratio of Ideko in 2010 is closest to:
A) 1.9
B) 1.7
C) 1.6
D) 1.8
Answer:
Suppose you have $10,000 in cash to invest. You decide to sell short $5,000 worth of
Kinston stock and invest the proceeds from your short sale, plus your $10,000 into
one-year U.S. treasury bills earning 5%. At the end of the year, you decide to liquidate
your portfolio. Kinston Industries has the following realized returns:
The return on your portfolio is closest to:
A) -0.5%
B) 13.5%
C) -2.5%
D) 14.5%
Answer: